Pakistani Government Announces Necessary Hike in Fuel Prices, But Risks Political Turmoil

Pakistan's Oil and Gas Regulatory Authority (OGRA) has announced a hike in petrol prices by 9.9% yesterday, performing a delicate balancing act between seeking to avert a worsening of the country's economic crisis while at the same time risking its very political survival. The increase of fuel prices, which was justified by the government due to a rise of prices in the international oil market following the political crisis in key oil producing economies in the Middle East and North Africa (MENA), will come into effect immediately. According to a statement of the Pakistan Oil and Gas Regulatory Authority, this means that the price of petrol will increase from 72.96 Pakistani rupees (USD0.85) to PKR80.19 per litre, while prices for diesel and kerosene will be increased at similar rates.

Outlook and Implications

A Risky Move…

Politically, the move could spell disaster for the coalition government led by the Pakistan Peoples Party (PPP). Already deeply unpopular due to its failure to rein in double-digit inflation rates following the July/August 2010 floods, the increase in fuel prices will spur further discontent from the poorest sections of the country. In an unsurprising move, the opposition, including the Pakistan Muslim League–Nawaz (PML-N) yesterday staged a walkout from the National Assembly, condemning the government's decision. In a worrying move, the Muttahida Qaumi Movement (MQM), a key coalition partner that forced the government to reverse a decision to hike fuel prices earlier this year by temporarily withdrawing its political support, also joined the walkout, saying that it was giving the government three days to reverse its decision. MQM spokesman Wasey Jalil warned that "the government has dropped a petrol bomb on its people", saying that "it will hike inflation and increase poverty", and adding that the MQM would decide its further steps after three days. It cannot be ruled out that it will again withdraw its support from the government. Similar walkouts were staged in the provincial assembly of Sindh, where the opposition wrote a joint resolution asking the federal government to reverse its decision, saying that it has "irritated and annoyed common men who are already agitating against the alarming price hike".

The move immediately triggered an indefinite strike of transporters in Pakistan's financial capital of Karachi. But protests are likely to spread further, and the opposition is likely to fan the flames. Indeed, the fuel price hike only adds a further issue on the list of opposition demands. The leader of the PML-N, Nawaz Sharif, on 28 February 2011 threatened that he was considering increased anti-government agitation if deemed necessary in the "larger national interest". Sharif, speaking to PML-N workers from several districts of Pakistan's southern Sindh province, said that activities such as the "Long March", which in March 2009 saw thousands of opposition supporters agitate against the PPP-led government to reinstate Supreme Court judges that were previously dismissed by former president Pervez Musharraf, could be replicated if the government continues to fail to act on his party's demands. After the PML-N on 25 February 2011 resolved to part ways with the PPP in Punjab's provincial assembly, saying that the government has made no progress in the implementation of its 10-point demand list which, among others, included more decisive actions against government corruption and a reduction of government expenditures by 30% (and earlier this year the reversal of the January fuel price hike), such a move is even more probable now.

While the opposition is unlikely to seek an immediate collapse of the government (as this could trigger unwanted military intervention), mid-term elections are now becoming an increasingly possible scenario. Should the MQM, which holds 25 seats in parliament, again withdraw its support, this would deprive the government of a working majority in parliament. There is also the risk of a "domino effect", which could see other coalition partners withdraw. Most immediately, this would complicate efforts to pass controversial legislation, including on crucial tax reforms, but this could effectively also lead the opposition to move for a no-confidence vote, which the government would likely lose.

The government's tightrope act highlights just how complicated, fluid, and shaky the political environment in Pakistan is. The government's position is greatly complicated by impossible expectations to tackle the country's many, often interrelated problems that include massive economic and socio-economic implications of the worst floods in history in summer 2010; massive security problems due to widespread militancy, especially in the Northwest; major economic instability; poor international relations, particularly with neighbours India and Afghanistan; and natural resource shortages. More broadly, Pakistan has a history of institutional weakness, poor governance and corruption.

…But Necessary

When prime minister Yousuf Raza Gilani in January announced the reversal of the government's decision to hike fuel prices, IHS Global Insight warned that this was an unsustainable move (see Pakistan: 7 January 2010: Failure to Cut Oil Subsidies in Pakistan Threatens Fiscal Stability, IMF Support). This assessment was made given that the government was making huge losses due to subsidies. OGRA spokesman Syed Jawad Naseem in a statement yesterday said that the government has had to pay out PKR13 billion rupees (USD153 million) in subsidies since the last price hike in November 2010, but also said that the government's woes are unlikely to be over with the latest rise as the global oil price has risen by more than 23% since then. This essentially makes further fuel price hikes a necessity, but as explained above it is so far unclear whether the government will even survive the latest increases.

Yesterday's price hike represents another attempt of the Pakistani government to curb its unsustainable budget expenditure. The country's domestic gasoline and electricity supply remains heavily subsidised, regularly driving its fiscal account into deep deficits, particularly when the gap between fixed domestic prices and highly volatile international oil market prices widens. Following the International Monetary Fund (IMF)'s requests for fiscal consolidation, the government implemented the first phase of subsidy cuts last year, when gas and petroleum prices were raised by 18% and 8%, respectively (see Pakistan: 11 February 2010: Inflation in Pakistan Rises Further on Higher Domestic Energy Prices). The second stage of subsidy cuts was scheduled for July 2010 but the devastating summer floods that caused close to USD10 billion in damage deferred the implementation of the reform. The unpopular 9% oil hike was again implemented in early January, only to be followed by the government's decision to scrap the measure days after, under heavy political pressure from the opposition (see Pakistan: 7 January 2011: Failure to Cut Oil Subsidies in Pakistan Threatens Fiscal Stability, IMF Support).

While still subject to major controversy and potentially another political crisis, yesterday's energy price hike carries at least two major reasons. The "hard" evidence of serious fiscal problems emanating from the government's failure to proceed with the fiscal reforms became available on Monday (28 February 2011), suggesting that Pakistan's fiscal deficit for the first half of the fiscal year (FY) 2010/11 (July-December) already reached 2.9% of an estimated GDP against the annual target of 4.7% of GDP (see Pakistan: 1 March 2011: Failure to Implement Fiscal Reforms Creates Six-Month Budget Deficit of 2.9% of GDP in Pakistan). If the government is unable to push through the reforms before the end of the fiscal year (June), the economy will face a serious risk of running a budget deficit close to 8% of GDP, as projected by IHS Global Insight.

Not only would the deficit undermine Pakistan's macroeconomic stability through unsustainable domestic borrowing necessary to finance it, but also the future of the external financing would be put under renewed risk. As the IMF remains the main foreign lender, with the USD11.3-billion loan programme still in place, the failure to meet the donor's main conditions—implementation of the Reformed General Sales Tax (RGST), subsidy cuts and the overall reduction of the budget deficit—would deprive the cash-staved nation of nearly the only source of stable foreign-exchange inflows. The disbursement of the loan has been already postponed several times, and the above-mentioned reforms remain critical conditions for the loan renewal. The IMF team is about to meet with the Pakistani authorities to discuss the country's performance under the programme and the possibility of the sixth loan disbursement in the near future. In this respect, the latest energy tariff hike ahead of the meeting is a clear demonstration of the government's dire need of the IMF's continuous commitment to the programme.

Industry Implications

For Pakistan's oil refiners the end-user fuel price hikes will not have a significant impact on their profitability, as their Gross Refining Margins (GRMs) are determined by ex-refinery product prices linked with international market prices of petroleum products on an import parity basis in the Arabian Gulf region. For fuel distributors, incentives to supply fuel will not increase as distribution margins of PKR1.72 per litre for High Octane Blending Components (HOBC) and PKR1.50 for Premium Motor Gasoline have remained constant from last month despite the price hikes. Oil product dealers will also retain the same commission rates as last month. However, their disappointment in not sharing the benefits of the fuel price hikes, coupled with the October 2010 reduction in dealer commission rates, has prompted protests from the Pakistan Petroleum Dealers Association (PPDA), which is demanding the government raise commission rates by PKR0.50 per litre. Some dealers reacted to the fuel price hike by closing fuel retail stations to place pressure on the government to meet their demands. The government appears to be defusing the issue by promising to consider their demands.

The chief benefactor from the fuel price hikes is the central government, who has significantly increased petroleum levies on Premium Motor Gasoline and HOBC and general sales taxes on fuel, which are factored into the maximum ex-depot sales price. The government's attempts to increase taxes on fuel sales are aimed at keeping Pakistan's budget deficit at just over 5.0% for the remainder of the fiscal year 2010/11. Increased fuel taxes are aimed at financing the government's fuel subsidy burden, which would otherwise significantly increase in line with discrepancies between surging import parity ex-refinery prices and regulated end-user fuel prices. High fuel subsidy expenditure potentially undermines Pakistan's access to much needed loans from International Financial Institutions (IFIs). Moreover, increasing government revenues are crucial in tackling circular debt issues in the energy sector. State fuel marketing company Pakistan State Oil (PSO) is owed large receivables for fuel consumed by various state power companies. PSO is dependent upon these power companies receiving financial allocations from the Ministry of Finance to back refiners for fuel procured. Increased fuel taxes should help the Ministry of Finance to make more timely payment to state energy firms, which could theoretically lower receivables across the supply chain. Nevertheless, the extent of non-payment backlogs as well as endemic corruption in the energy sector suggests that increased revenues from fuel taxes are no panacea for solving the enduring circular debt issue.